Klein's Commentary

Go beyond the headlines

China’s Questionable Market Recovery

Money has to stay fit. It gets soft just lying on the couch, feet up on the coffee table, flipping through reality TV shows.  And this week the money looks like its running back to Asia.

The Shanghai composite index jumped 2.87% on Wednesday prompting a flurry of reporting on the re-awakening of China’s stock market. What a jump. Better days here we come . . .

Chart Source: Yahoo Finance

But before we get ahead of ourselves, take a look at the year-to-date chart.

Chart Source: Yahoo Finance, annotations added.

Yes, it’s that little blip at the bottom edge of the chart. The same uptick that occurred once in October, twice in September, and once in August and June as we climb backwards up the downward facing slope (not a yoga move).

 

For even greater perspective take a look at the last five years while the collective West was supposedly entering inevitable decline, imploding under the weight of its own capitalistic excesses. The mole hill made mountain is just barely visible, way down there in the corner, like the raw unamplified light of a distant galaxy.

Chart Source: Yahoo Finance, annotations added.

Even more illustrative than all the hype surrounding this minor bump is the shape of the longer Shanghai curve. The “V-shaped recovery” ended unceremoniously in July 2009 turning into a long, sustained slump (losing over 40% of its value in the last three and half years.) Compare that to the S&P 500 in the “declining” U.S. over the same period (in orange). The S&P elongated “U”-shaped recovery just keeps going (a rocky road, but climbing), and up 20% from Shanghai’s July 2009 peak.

Chart Source: Yahoo Finance, annotations added.

Fundamentally little has changed in the Chinese economy to warrant sustained optimism about stock market recovery. There has been excessive infrastructure investment which will have questionable returns going forward. Local governments are saddled with rising debt. Land development projects increasingly go unfilled or unfinished.  And accounting scandals continue to rock the boat of listed companies, several of which are leaving U.S. markets because of detailed reporting requirements (read investor protection).

Talk of a Chinese soft landing and bounce-back have been de rigeur for some time. There wasn’t a mortgage market bust or banking crisis like in the U.S. (though there are signs of significantly under-reported bank liabilities, off-balance sheet transactions, “alternative” funding schemes, and real estate inventory backlogs of staggering proportions.) But then again, soft-ish landing doesn’t rule out slower days ahead. The U.S. hard landing actually resulted in a far stronger market recovery it turns out. For a sober analysis of China’s financial predicament see Michael Pettis’s “Three cheers for new data?“.

None of this means you can’t make a mint on short-term trading (full disclosure, I am not a short-term trader), but a small spike in an otherwise downbeat cycle hardly marks a trend. Money keeps running the treadmill in the basement to try and stay fit. Funny thing about home exercise equipment, after a few good runs it rarely gets used again.

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Brian • December 6, 2012


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